Tax Shield Education Pvt. Ltd.

Cost Accounting-
Short Questions
1. Discuss the four different methods of costing along ith their a!!lica"ilit# to industr#.
Answer: Four different methods of costing along with their applicability to concerned industry
have been discussed as below :
1. Job Costing $ The objective under this method of costing is to ascertain the cost of each
job order. A job card is prepared for each job to accumulate costs. The cost of the jobs is
determined by adding all costs against the job when it is completed. This method of
costing is used in printing foundries and general engineering wor!shops advertising etc.
". #atch Costing $ This system of costing is used where small components$ parts of the
same !ind are re%uired to be manufactured in large %uantities. &ere batch of similar
products is treated as a job and cost of such a job is ascertained as discussed under 1
above. 'f in a cycle manufacturing units rims are produced in batches of "()) units
each then the cost will be determined in relation to a batch of "()) units.
*. Contract Costing $ 'f a job is very big and ta!es a long time for its completion then
method used for costing is !nown as Contract Costing. &ere the cost o each contract is
ascertained separately. 't is suitable for firms engaged in the construction of bridges
roads buildings etc.
+. ,perating Costing : The method of Costing used in service rendering underta!ings is
!nown as operating costing. This method of costing is used in rendering services li!e
transport supply of water telephone services hospitals nursing homes etc.
%. Define Product costs. Descri"e three different !ur!oses for com!uting !roduct costs.
Answer : -roduct costs are attributable costs. These are the costs which are assigned to the
product. .nder marginal costing variable manufacturing costs and under absorption costing
total manufacturing costs constitute product costs.
-urposes for computing product costs : The three different purposes for computing products
costs are as follows :
i. Preparation of financial statements : &ere focus is on attributable costs.
ii. Product pricing : 't is an important purpose for which product costs are used. For this
purpose the cost of the areas along with the value chain should be included to ma!e the
product available to the customer.
iii. Contracting with government agencies : For this purpose government agencies may not
allow the contractors to recover research and development and mar!eting costs under
cost plus contracts.
&.. 'o does a Production Account differ from a Cost Sheet.
Answer The following are the points of difference between a -roduction Account and a Cost
/heet :
1. -roduction Account is based on double entry system whereas cost system whereas cost
sheet is not based on double entry system.
". -roduction Account consists of two parts. The first part shows cost of the components
and total production cost. The second part shows the cost of sales and profit for the
period. Cost sheet presents the elements of costs in a classified manner and the cost is
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Tax Shield Education Pvt. Ltd. Cost Accounting-
ascertained at different stages such as prime cost0 wor!s cost0 cost of production0 cost of
goods sold0 cost of sales and total cost.
*. -roduction account shows the cost in aggregate and thus facilitates comparison with
other financial accounts. Cost sheet shows the cost in detail and analytical manner which
facilitates comparison of cost for the purpose of cost control.
+. -roduction account is not useful for preparing tenders or %uotations. 1stimated cost
sheets can be prepared on the basis of actual cost sheets and these are useful for
preparing tenders or %uotations.
(. S!ecif# the methods of costing and cost units a!!lica"le to the folloing industries :
'ndustry 2ethod of costing .nit of cost
i. Toy ma!ing #atch -er batch
ii Cement .nit -er tonne or per bag
iii. 3adio 2ultiple -er 3adio or per batch
iv. #icycle 2ultiple -er #icycle
v. /hip building Contract -er /hip
vi. &ospital ,perating -er #ed per day or
per patient per day.
vii. City #us Transport 4o per -assenger 55 !ms.
viii. &otels providing lodging facilities 4o per 3oom $ day
). *ne of the im!ortant and s!ecial !ro"lems in accounting of materials relates to those
concerning SC+AP, SP*-LA.E, /ASTE and DE0ECT-1ES. Distinguish "eteen these and
state ho each of them shall "e accounted for. 'o are the# controlled 2
Answer.
Scra! $
/crap is discarded material having some value. 't is also in the form of incidental residue to
certain type of manufacturing activities. 't usually has low value which is recoverable without
further processing. /crap also represents loss of basic raw material which is conse%uential
residue of some type of manufacturing activities. 't is always visible and it always visible and it
always fetches some value. 6umerous e7amples of scrap may be given 8 turnings borings
trimmings filings shavings etc. from metals on which machine operations are carried out 0
sawdust and trimmings in the timber industry0 dead heads and
bottom ends in foundries0 and cuttings pieces and splits and splits in leather industries.
S!oilages $
/poilage refers to production that does not meet with dimensional or %uality standard in such a
way that it can be rectified economically and is jun!ed and sold for a disposal value. 't
represents loss of defective production which can not be finished. /poilage can be made to
realise some value after application of some more material labour or overhead. This spoilage
represents loss of material labour and overhead on production which can not be brought to
finished stage.
/aste $
9aste is define as discarded substances having no value. 't is that part of material which is
either lost shrin!s or evaporates in the manufacturing process and hence invisible or a residue
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Tax Shield Education Pvt. Ltd. Cost Accounting-
which is visible but having no measurable recovery value. /ometime waste disposal entails
additional e7pense vi:. atomic waste. 9aste may be due to the following reasons :
1vaporation of oil paints etc.
;osses inherent to brea!ing bul! as in the case of coal.
Absorption of moisture as in the case of lime etc.
6atural deterioration i.e. dusting.
Defective $
4efective products or units are those which do not meet with dimensional or %uality standards
and are rewor!ed for rectification of defects by application of material labour and $ or processing
and salvaged to the point of either standard product or sub5standard product to be sold as
seconds. 'f the defect is such that even after rewor! or reconditioning it can not be sold as
seconds then it becomes scrap or as an e7treme case may be waste.
3. T'E ACC*45T-5. *0 SC+AP, SP*-LA.E, /ASTE A5D DE0ECT-1E /*+6S -51*L1ES T'E 0*LL*/-5..
i. Costing or valuation of the scrap spoilage waste etc.
ii. Accounting in product costs
iii. Control of scrap spoilage and waste etc.
7. Scra! Accounting $
Accounting treatment of scrap depends on the realisable value.
9here value of scrap is negligible absorb the cost and the realised amount from sale of scrap
will be treated as other income.
9hen value of scrap is significant and identifiable with job or process the cost will be transferred
to scrap account and the realisation from sales will be credited to job or process account. The
difference will be transferred to costing profit and loss account.
9hen value is significant but scraps are not identified with particular job or process the net
realisation after deducting selling cost is transferred to either overheads or material account to
reduce the overhead rate or material cost respectively.
Control of scra! $
/crap control starts from the designing of product and process. 1fforts shall be made to
ma7imise utilisation of material and minimum wastage of material in the processing. A standard
allowance for scrap should be fi7ed and actual should be compared against it. A periodical
report indicating type of scrap nature of product good production units scrap units 8 actual and
normal < scrap to good units and standard allowance < and value of scrap etc. should be
prepared from the data collected at the shop level and placed before the 4epartmental &ead for
review and remar!s.
S!oilage $
Accounting $
Cost of normal spoilage which is inherent in the operation is absorbed by charging either to the
production order or to production overheads. Cost of abnormal spoilage arising out of causes
not natural to the manufacturing process is charged to costing profit and loss account. As
regards charge to production there are two methods 8
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Tax Shield Education Pvt. Ltd. Cost Accounting-
'dentifying loss arising out of spilage and
Absorbing in the value of good units so that spoilage %uantity or value is not identified.
'f spoiled units are reused as raw material in the same manufacturing process no separate
accounting treatment is re%uired. ,n the other hand if spoilage is used for any other process or
job a proper credit should be given to relevant process account or job account.
Control $
Control of spoilage is e7ercised by setting standards fi7ation of responsibility and systematic
reporting.
/aste $
Accounting $
=ood units should absorb the cost of waste. &owever if any value is realised the process
account concerned may be credited. Cost of abnormal waste should be e7cluded from the total
cost and charged to the costing profit and loss account.
Control $
Control is e7ercised over the %uantum of waste arising in a process or operation usually through
standard set for the normal percentage of visible and invisible wastes that may be anticipated to
arise in various manufacturing processes or operations.
'n order to !eep a control on waste a periodical report should be prepared by each department
indicating >a? 6ature of waste >b? @uantity of waste generated >c? Aalue if any and >d?
-ercentage comparison between normal and actual waste. Control action consists of review by
departmental head and corrective action is ta!en especially if wastage is abnormal.
Defective $
Accounting $
Cost of defectives includes reprocessing e7penses such as material labour direct e7penses
which will add to the cost of job or process as a direct e7pense.
&owever if the e7pense is not identifiable with the particular job or process and the amount is not
significant the total e7penses shall be collected by way of a standing order number and charged
to the departmental overheads or general overheads. 'f defectives are abnormal and are due to
causes beyond the control of the organisation0 say power failure at the time of rewor!ing the cost
of rewor! should be debited to costing profit and loss account. 't should be noted that cost of
remedying imperfection is not the cost of the particular job on which the defective wor! was
discovered. The cost of defective wor! is considered as an item of manufacturing overhead.
Control $
1ffective control has to be e7ercised on the physical units of defectives as well as on the cost of
salvaging. #est way is to fi7 standard or norms for defectives and rewor! and rectification costs
and compare actual against them.
3eports on defective wor! should shown the reasons for the e7cess defective wor! and should
be prepared for each department or each department or each foreman for proper fi7ation of
responsibility. The reports may also be made out for each individual job or production order in
which case the details of material labour and overhead costs up to the point or stage of
rejection may also be shown.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
8. Scra!s and S!oilage During Trial +un of E9ui!ments :
9hen a new e%uipment is installed generally it ta!es some time for it to wor! with normal
efficiency. 'nitially some trial runs are re%uired to ma!e sure the e%uipment is running on
capacity.
4uring such trial runs the e%uipments may result into substantial scraps and spoilage without
any commensurate output. /uch abnormal scrap ta!ing place at the initial stage should not be
charged to normal output because the normal cost could then be vitiated. 2ost concerns prefer
to boo! the value of initial scrap due to teething problems as part of the capital cost of the
e%uipment. Alternatively this may be charged to deferred revenue a$c. and recovered over a
period of ne7t five years. A third alternative is to boo! the entire scrap to Costing -rofit and ;oss
Account -rovided the amount is not large and can be absorbed in one year.
:. Small tools are mechanical a!!liances used for various o!erations on or; !lace,
s!eciall# in engineering industries. Such tools drill "its, chisels, scre cutter, files etc.
Treatment of cost of small tools of short effective life :
>i? /mall tools purchased may be capitali:ed and depreciation over life if their life is
ascertainable. 3evaluation method of depreciation may be used in respect of very small
tools of short effective life. 4epreciation of small tools may be charged to :
55 Factory overheads
55 ,verheads of the department using the small tool
>ii? Cost of small tools should be charged fully to the departments to which they have been
issued if their life is not ascertainable.
1<. Pac;ing Cost $
Containers$-ac!ing materials are of two types5primary and secondary. -rimary containers are
essential to put the goods in a saleable condition li!e in! in a bottle jam in a jar etc. /econdary
containers are re%uired for delivery$transportation li!e crates etc they are returnable and
reusable.
The cost of primary containers should be charged off as a production overhead and included in
production cost. ,n the other hand the cost of secondary containers should be charged off as a
selling and distribution overhead. The cost of reusable containers should be charged when they
could not be used anymore due to damage wear and tear etc.
'n some cases the primary pac!ing materials may be made decorative with a view to promote
sales and in such a case a part of the cost of the primary pac!ing materials should be
apportioned as a selling cost.
11. +o#alties $
3oyalties are prices paid to ac%uire the right to manufacture or to produce the cost of the royalty
should be charged as a production cost and included in production overhead. 9here however
the royalty is the price or the right to sell the cost of such royalty should form a part of selling and
distribution cost and included in selling overheads. 'f a combined royalty is paid both for
production and sales the cost of such royalty should be apportioned between production cost and
selling cost on some e%uitable and appropriate basis. 'f a concern produces$sells more than one
product such royalty cost should be treated as a direct cost of the particular product.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
1%. =ad De"ts $
#ad debts occur when some of the debtors fails to honour the commitments to pay and the
organi:ation suffers a loss in the sense that they do not receive the price for goods sold or
services rendered. #ad debts are usually considered part of selling and distribution overhead. 't
is also a debatable point in the sense that some accountants feel that bad debts arise out of
financial policy and should not be ta!en into cost accounting altogether.
These e7penses should be charged off directly in the Costing -rofit and ;oss Account. 'n case
when bad debts are included in costing and are considered as part of selling overheads this
should be divided into normal and abnormal elements. 9hen bad debts are within normal limits
they should be absorbed in selling overheads as normal charge and when they are beyond the
normal limits they should be charged off to -rofit and ;oss Account thereby not being considered
in the cost.
1&. -nterest on "orroings for or;ing ca!ital $
/ince wor!ing capital is a part of the ownerBs fund the remuneration for this is earned by the
owners and partners by way of profit or share of profit or dividend as the case my be. Therefore
interest on wor!ing capital funds should not normally feature in costing and in product cost.
9here however a part of the wor!ing capital is borrowed from ban!s$financial institutions or
from other sources the interests on such borrowing may justify inclusion in costing being an item
of e7penditure chargeable to the -rofit and ;oss Account.
1(. *"solescence
't represents the loss arising as a result of having to discard an asset due to its suppression in
favour of a more productive asset at an earlier date than planned$contemplated. 't is sometimes
called Ce7ternal depreciationD because the e7isting asset is replaced by a new asset on account
of invention$innovation.
The loss due to obsolescence to fi7ed assets may be dealt with in the following manner :
>i? 'n industries which are vulnerable to the ris!s of obsolescence e.g. electronics it is
somewhat predictable that obsolescence will ta!e place with certain fre%uency. 'n such
case higher rates of depreciation may be charged to ta!e care of such obsolescence.
>ii? For industries which are not vulnerable to fre%uent obsolescence it is prudent to create a
reserve fund to ta!e care of such eventualities.
>iii? For other industries bearing a remote possibility of obsolescence in the event of
obsolescence ta!ing place loss is to be written off to -rofit and ;oss Account.
1). Tool Cost $
Tools may be classified as >a? large tools and >b? small tools large tools are normally capitalised
and depreciation charged to Factory ,verheads. For small tools the following treatment may
apply :
>'? Capitali:ation 2ethod5in line with large tools.
>ii? 3evaluation 2ethod5At the end of the year revaluation for unused life of the tools is made
and the difference between original cost and revalued cost is charged as factory
overheads.
>iii? 9rite5off 2ethod. 9henever such small tools are issued to department the department is
debited with the cost. Alternatively cost of tools issued during a period is accumulated and
distributed to various departments on some suitable basis e.g. hours wor!ed.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
13. Controlla"le costs and uncontrolla"le costs $
Costs which can be influenced by the action of a specified person in an organisation are !nown
as controllable costs. Cost which remains unaffected by the action off such a person are termed
as uncontrollable. 'n a business organisation heads of each responsibility centre are responsible
to control costs. Costs which they are able to control are !nown as controllable and includes
material0 labour and direct e7penses. Cost which they fail to control includes fi7ed costs and all
allocated costs.
't may be noted that controllable and uncontrollable cost concepts are related to the authority of a
person in the organisation. An e7penditure which may be uncontrollable by one person may be
controllable by another. 2oreover in the long run all costs may be controllable.
17. Chargea"le Ex!enses $
These are the e7penses which can be charged directly to jobs products processes cost centres
or cost units. These are also !nown as direct e7penses. 4epending on the situation the same
item of e7penses may be treated as a chargeable e7pense or an indirect cost. For e7ample the
rent charges of a machine specifically hired to complete a particular job will be a direct charge on
the job. #ut if the same machine is used for various purposes then the rent charges will be
treated as an indirect cost and are apportioned to concerned cost centres on an e%uitable basis.
The following may also be treated as chargeable e7penses in relation to a product or job :5
1. Cost of patents.
". &ire charge in respect of special machinery or plant.
*. Architects surveyors and other consultantBs fees.
+. Traveling e7penses to site.
(. Freight inward on special material.
18. Cash Discount >on !urchase of materials?
These are discounts obtained for settlement of invoices for purchase of materials within the time
stipulate by the supplier. There are divergent views on the treatment of cash discount in cost
accounts. ,ne view is that discount represents a reduction of material cost and therefore should
be deducted from invoice price. The other view is that Cash 4iscount is available because of
good financial management and therefore the discount should not be deducted from invoice
price. 'f the former view is accepted it may lead to complications because if the discounts are not
ultimately availed they have to be added bac! to materials cost which may have been already
issued to production. 't is preferable to treat this as an item of finance and e7clude the same from
cost accounts. 'f however the cash discounts are regularly availed of through prompt payment
materials cost may be reduced by such discount.
1:. Cost control and Cost +eduction $
Cost Control is the guidance and regulation by e7ecutive action of the costs of operating an
underta!ing. 't includes planning communication motivation reputing and decision ma!ing. Cost
reduction may be defined as the achievement of real and permanent reduction in the unit cost of
the products manufactured. 't thus aims at achieving real savings in the various costs relating to
production sales distribution etc. The following distinction may be made between them55
>'? Cost Control implies setting up for norms or targets through budgets standards forecasts
etc. and efforts made to achieve them. Cost reduction donates systematic efforts to
improve the targets set by better designs improved planning and organi:ation.
>ii? 'n Cost Control /tandards or #udgets once set up are accepted and not challenged
whereas in the case of cost reduction the very standards$budgets are challenged and
efforts are made to improve upon them.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
>iii? Cost control is a basically preventive function where by the result$goal is achieved by
!eeping to a standard. Cost reduction is a corrective action and continuous efforts are
made to correct or adjust the present standards or budgets.
>iv? Cost reduction has dynamic approach with a much wider there embracing product design
factory layout production control etc. whereas Cost Control is not so dynamic having
limited scope of staying within the predetermined standards and budgets.
%<. Conversion Cost $
Costs of converting material input into semi5finished or finished products i.e. additional
direct materials direct wages direct e7penses and absorbed production overhead.
/uppose the cost of producing > up to factory level? one unit of product A is 3s. E( and the direct
material cost per unit is 3s. ") then the conversion cost per unit of A is 3s. >E(5")? F 3s. ((.
The concept of conversion cost is used in case when the direct materials are of standard nature
and is not a significant factor in terms of the total cost of production. 9hen the budgetary control
system is in operation conversion cost concept may become very useful in ma!ing the system a
success.
/un! cost:
&istorical costs or the costs incurred in the past are !nown as sun! cost. They play no role in the
current decision ma!ing process and are termed as irrelevant costs. For e7ample in the case of a
decision relating to the replacement of a machine the written down value of the e7isting machine
is a sun! cost and therefore not considered.
,pportunity cost:
't refers to the value of sacrifice made or benefit of opportunity foregone in accepting an
alternative course of action. For e7ample a firm financing its e7pansion plan by withdrawing
money from its ban! deposits. 'n such a case the loss of interest on the ban! deposit is the
opportunity cost for carrying out the e7pansion plan.
%1. Canteen Su"sid#
Canteen /ubsidy is generally treated as an overhead cost. Canteen e7penses are boo!ed in a
separate standing order number and all receipts from the wor!ers are credited to the same. The
net cost representing the canteen subsidy met by the organi:ation is then apportioned to the
cost$profit$service centers in any of the following basis
>'? Total wage cost
>ii? Total number of employees employed.
>iii? Total number of employees served.
>iv? Total number of meals served.
%%. Data Processing Cost
4ata processing is a service activity and the related cost should be allocated to various
departments who use the services of the 4ata processing department. The most accurate basis
of allocation of this cost should be number of cards punched or tapes processed relating to
various user5departments. 'n large organi:ations this basis may prove to be impractical. The
alternative methods which may be used are >a? 6umber of reports processed pointed >b?
standard percentage >c? computer hours >d? man5hours in 4ata processing department. The
operating divisions may also bear the cost on the Cability to payD basis. /ince this is an indirect
cost there may be various methods available for allocation but any method once selected should
not be changed too fre%uently unless compelled to so than the consistency of allocation may be
maintained.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
%&. Directors@ fees and Salaries.
4irectorsB Fees etc. represent Administrative ,verheads. 4irectorsB remuneration is sharable
between wor!s administration selling and distribution when they loo! after different functions on
the basis of time devoted to each function. 9hen there is separate directors to loo! after such
functions vi:. /ales Finance personnel -roduction etc. their fees and salaries should be
grouped under such functional costs and thereafter apportioned to cost units as overhead costs.
%(. Dismantling and re-installation of Aachiner# in the Same Sho!? $
't may be found over a time span that the original layout is ineffective with the changes in time
outloo! troth in business technological development etc. necessitating readjustment of location
and of resting of 2achineries. 'n such a situation such cost may be written off to profit and loss
A$c.
'f on the contrary reinstallation is planned to result in an improvement in productivity this may be
treated as factory overhead either as current or deferred cost. 'f the benefits are to be derived
over a longer period the cost may be treated as deferred revenue and spread over a period of (
years. 9hatever be the cause of dismantling and re5sitting the cost should be treated as revenue
cost unless the dismantling is for the purpose of e7pansion of shop or factory.
%). Excavation Ex!enses for an a"andoned !roBect.
This is an unusual e7penditure and therefore should be !ept outside the purview of costs
accounts and charged directly to -rofit and ;oss Account. 'f the amount involved is considered to
be unreasonably burdensome during an accounting period then the same may be spread over
an appropriate number of years but the period should not be too long.
%3. Co" Costing and Process Costing
Job Costing -rocess Costing
1. Job costing is a specific order costing. -rocess costing is a method is a method of .
costing used to ascertain the cost of a . product at each process or stage of .
manufacture.
". Cost5here is determined on job basis. Costs are accumulated for each process .
separately for a given period of time.
*. 1ach job needs special treatment and no Finished product of one process becomes
two jobs are ali!e. The raw material for the ne7t process.
+. The cost of each job is complied The unit cost here is the average cost of
separately by adding materials labour the process for a given period. 'ts correct
and overhead costs. computation re%uires the measurement of
production at various stages of manufacture.
(. Costs are computed when job is Costs are computed for each process at
completed. the end of each period.
G. As each job is distinct or is of different As the processes operations are
standardised
nature more details supervision and sed accumulation of costs and supervision
control are necessary. and control are comparatively easier.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
%7. .oods +eturned "# Customers on +eBection
'f the goods returned by customers are resalable in alternative mar!ets only the cost of outward
freight and the e7penses incurred on getting the goods bac! from the original customer will be
treated as selling overheads. 'f the goods are rejected on %uality grounds and there is no chance
of their being sold an management has to scrap the product then the cost of production less the
net reali:able value of the scrap if any will have to be treated as factory overheads.
/imilarly if the goods have deteriorated in %uality while in storage at sales depots and have been
ultimately rejected by the Customer the cost of sales less net reali:able value of scrap if any
may be treated as selling overheads.
The above treatments apply to normal losses. 'n case of unusual loss caused due to such
rejection the same may be transferred to Costing -rofit$;oss Account.
%8. 'istorical Costing :
Costing is a techni%ue and process of ascertainment of costs. The techni%ue in costing consists
of principles and rules which govern the procedure of ascertaining costs of products or services.
The techni%ue is dynamic and changes from time to time and according to circumstances. There
are many types of costing of which historical costing is one and widely used. 'n H&istorical
CostingB cost are ascertained after they are incurred. &istorical Costing therefore means the
actual cost and does not consider any standard or estimated cost. This type of costing though
presenting the actual cost is losing importance to the
%:. -nterest on Ca!ital :
There are divergent views on this item. /ome argue for its inclusion in HcostB and have points in
support and others do not regard it as a part of HcostB.
The argument for inclusion of interest in cost are that interest is a reward for capital and that real
profit cannot be ascertained without ta!ing interest into account. 'n order to ma!e intelligent
comparison of cost it is necessary to include notional interest when financing is done out of own
capital. #ut the argument against inclusion of interest in cost are that the re%uired of capital is
profit and not interest. Comparison of costs can be drawn up on a proforma basis without
complicating cost accounts by including interest. 'nterest on borrowed capital is a matter of
convenience and as such need not be brought into accounts. #alance of opinion is against
inclusion of interest in costs. #ut at the same time the inclusion or e7clusion of interest in cost
should not influence the management in formulating policy decisions because the impact of
interest will have to be considered by then while arriving at decisions.
&<. 5ormal Loss in material usage
The treatment of normal loss or scrap would depend on the circumstances in which they arise. 'n
case these are produced in the usual course of manufacture and are considered to be normal
and inevitable due to inherent nature of the process these can be covered by normal
allowances. The operation or job from which they occur bears this loss. 'f however these items
possess a disposal value then depending upon the future processing cost or storage cost to be
incurred the residual value may be credited to the respective process operation or job thereby
reducing the net loss of material cost.
&1. *"solescence of 0ixed Assets.
,bsolescence represents the loss arising as a result of discarding an asset due to its
suppression in favour of a more productive asset at an earlier data than planned$contemplated. 't
is sometimes called Ce7ternal depreciationD because the e7isting asset is replaced by a new
asset on account of invention$innovation.
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Tax Shield Education Pvt. Ltd. Cost Accounting-
The loss due to obsolescence to fi7ed assets may be dealt with in the following manner :5
>i? 'n industries which are vulnerable to the ris!s of obsolescence e.g. electronics it is
somewhat predictable that obsolescence will ta!e place with certain fre%uency. 'n such
cases higher rate of depreciation may be charged to ta!e care of such obsolescence.
>ii? For industries which are not vulnerable to fre%uent obsolescence it is prudent to create a
reserve to ta!e care of such eventualities.
>iii? For other industries bearing a remote possibility of obsolescence in the event of
obsolescence ta!ing place loss is to be written off to -rofit and loss Account.
&%. *"solescence.
2ay be relating to fi7ed assets products finished goods materials and wor! in progress.
,bsolescence with regard to fi7ed assets arises when before the e7piry of normal life of an
asset it needs replacement by a new and improved asset. 't may also arise due to
discontinuance of the product or alternative wor! for the fi7ed asset being available.
-roduct obsolescence arises when due to technological changes a better product is developed
and therefore e7isting product cannot meet the mar!et competition. #ecause of product
obsolescence obsolescence in finished goods >e7isting product? wor! in progress and materials
>re%uired for the production of the product that has become obsolete ta!es place?.
&&. +ectification /or;
The rectification wor! on finished goods or a job may be carried out at the factory premises
before dispatch to customers or at customersB place subse%uent to dispatch. The reasons for
carrying out such rectification wor! may be attributable to manufacturing defects use of sub5
standard components mishandling during transit etc. 2inor rectification wor! can be treated as
manufacturing overheads or selling overheads as the case may be. &owever cost of major
repairs and replacement of e7ceptional nature should be treated either as a deferred charge or
written off to Costing -rofit$;oss Account.
&(. Sales Promotion Ex!enses
As the name suggests /ales -romotion 17penses are incurred to promote sales of an
organi:ation. These e7penses are incurred to promote sales promotion which in turn depends
on the business policy of the organi:ation. .nli!e manufacturing e7penses where nature and
amount of the e7penses are closely lin!ed with production sales promotion e7penses are lin!ed
with the mar!eting policy of the organi:ation.
=enerally sales promotion e7penses include advertisements in /ouvenir -osters /ign5boards
6eon5signs etc. /ales promotion e7penses should be treated as deferred revenue e7penditure to
be charged off as overheads over a period because the benefits arising out of sales promotion
policy are e7pected to accrue over a fairly long period of time say E$1) years. The apportionment
of such costs on to particular products may be done on incremental sales achieved due to the
promotional drive. 'f the sales promotion is underta!en for a short period and the amount spent is
not large e7penses on such promotion may be written off in the same year under selling and
distribution overheads.
&). 1alue Anal#sis
't is one of the important tools of modern management in the area of cost reduction. 't is also
!nown by other names such names such as value engineering value control and product
research. Aalue analysis is the process of systematic analysis and evaluation of various
techni%ues and functions with view to improve organi:ational performance. 't aims at reducing
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and controlling the cost of a product form the point of view of its value by analysing the value
currently received. 't investigates into the economic attributes of value analysis believes in a
planned action to improve performance and thereby generates higher value in a product and
ultimately causes reduction in its cost.
The meaning of the term value may vary from person time to time and place to place. &owever
in the conte7t of cost reduction and control it refers to the Huse valueB.
The reduction in the costs of a production in the costs of a product and thus increasing the
profitability of a concerns is the main advantage of value analysis.
The benefits of value analysis are being derived in many industries e.g. engineering building
construction and the oil industry. 't is being applied to components of a product finished product
and also to the methods of pac!ing.
The various steps involved in value analysis are0
i. identification of the problem0
ii. collection information about the function design material labour overhead costs etc. of the
product and finding out the availability of the competitive products in the mar!et0 and
iii. e7ploring and evaluating alternatives and developing them.
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